New Bull Market or Bear Market Rally?

This is the question that is on everyone’s mind and there is no shortage of opposing views. The end of bear markets is always difficult. Sharp market rallies in the middle of severe bear markets are quite common. In fact, some of the sharpest rallies in the history of the stock market have come during the middle of bear markets. The bear markets of 2001 and 2008 had some face melting rallies in between large drawdowns. The problem with the end of bear markets is that you can never really be sure if a bear market rally is the start of a new bull market until the rally has been going on for quite some time. So….is the rally in the market that started in early January the start of a new bull market or just another bear market head fake? Let’s take a look at both sides.

The Bull Case

1. The market broke out above its downtrend line and held that level over multiple trading sessions. This is important and typically a strong signal that, at least for now, the downward pressure on the market is reduced. This is also typically when people who are short of the market tend to start buying shares to cover, which pushes the market even higher. See the chart below of the S&P 500 breakout over its downward sloping trendline. This is roughly a 3-year chart.

2. The market has been resilient in the face of a tough Federal Reserve and sub optimal corporate

earnings. Sometimes the market just wants to defy all logic and go up, which is a good sign.

Earnings, especially mega cap tech earnings, have been lackluster at best. The economic data has

not been great. Yet…the market has shrugged it off. A resilient market is something that we look

for in a sustained strong market.

3. Inflation is coming down quickly. The monetary tightening measures taken by the Federal

Reserve in 2022 seem to be having a positive effect on inflation. This is essential to the end of

the bear market.

The Bear Case

1. The January rally has been led by low quality tech. This is not ideal. The stocks that got demolished by 50%-70% last year are the ones that are leading the rally. These are absolutely not the type of companies that one would want to own going INTO a recession. These are exactly the type of stocks one would want to own coming OUT OF a recession. The fact that high volatility and low-quality stocks are leading the rally before a recession has even happened makes it feel like a short covering FOMO rally and not a sustainable new bull market. Of course, this is dependent on whether we are actually going into a recession. Many of the historical predictors of recession are ringing the recession bell, but every market is different. In this case, it is possible that a strong employment market and strong housing market could prevent a recession. Unlikely, but within the realm of possibility.

2. The impact of the Federal Reserve’s unprecedented monetary tightening from 2022 has not been felt yet and the end result is unknown. We are in uncharted territory here. The Federal Reserve has raised rates twice as fast as any time in recent history. Also, the Federal Reserve typically raises rates when the economy is strong, not when the economy is weakening.

3. Examples from the past.

2000-2002: From the peak of the internet bubble in early 2000 the market fell by

about 26% over 12 months (similar to 2022). In early 2001, the market sharply rallied

about 16% over a 2-month period. The market then fell another 38% over the next 18

months before finding a real bottom.

2008-2009: From the peak of the housing bubble, the market fell 20% over an 8-

month period. The market then sharply rallied around 15% over 2 months before falling

another 50% over the next 10 months before finding the real bottom.

Summary

There are valid points being made on both sides, which is why there is so much disagreement between market participants regarding the path of the market moving forward. Strong housing and employment are quite positive. The fact that defensive sectors are lagging this year is a positive. Here appears to be a lot of cash sitting on the sidelines that, if deployed, would likely flow into the stock market, which is a positive. However, the lagging effect of monetary tightening is the key unknown negative. At this point we believe that a moderately defensive posture is prudent with a higher-than-normal amount of cash on the sidelines to take advantage of market dips.

Note: The two past examples I provided sound scary. However, every market has different circumstances and past cycles are not destined to be repeated. In each of those two cases, the market rallied heavily for years after each of those rough patches.

This commentary on this article reflects the personal opinions, viewpoints and analyses of the Element Squared Private Wealth employees providing such comments and should not be regarded as a description of advisory services provided by Element Squared Private Wealth or performance returns of any Element Squared Private Wealth client.

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